Why the Money Supply is Flat

May 24, 2010

John Mauldin is the author, writer and editor of the popular (and free) Thoughts from the Frontline e-letter which goes to well over 1,000,000 readers weekly, and is posted on numerous independent websites. He also edits the free weekly e-letter “Outside the Box” which features the writing of original thinkers on a wide variety of subjects.

In his most recent newsletter, entitled The Case for a Fed Rate Hike (May 22, 2010), John writes about a variety of topics including employment, the money supply, inflation and the inverted yield curve.

Most interesting is Mauldin’s analysis of the money supply. He notes that the growth in the money supply is slowing. And points out that one of the measures of money supply called the MZM (Money of Zero Maturity) has been flat for well over a year and was actually down the last two months.

The broader M2 money stock has also flat-lined for well over a year, a phenomenon, as points out that has not occurred over the last 30 years.

In both measures there was a large increase beginning in the middle of 2008 as the Fed pumped the money supply in order to inject liquidity into the system. This was basically the $1.25 trillion purchase of mortgages. However, as Mauldin points out, the Fed’s intervention was not boosting the money supply as much as it did in the beginning.

Why? Due to the tremendous decrease in lending by commercial lending at US banks which is down almost 25% in less than a year and a half.

With the money supply slowing, Mauldin believes the Fed will not be reducing its mortgage holdings any time soon. That will come when it is obvious that a recovery is firmly entrenched. He doesn’t see a scenario where they can risk reducing the money supply any more than they already have, especially given the subdued outlook for inflation for some time to come.

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